Moving Up the Value Chain

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Moving up the Value Chain:

Upgrading Chinas Manufacturing Sector

Pan Yue

Party School of the Central

Committee of the Communist

Party of China

Simon J. Evenett

University of St. Gallen and Centre

for Economic Policy Research

July 2010

Moving up the Value Chain: Upgrading Chinas Manufacturing Sector i

2010 International Institute for Sustainable Development (IISD) Published by the International Institute for Sustainable Development IISD contributes to sustainable development by advancing policy recommendations on international trade and investment, economic policy, climate change and energy, measurement and assessment, and natural resources management, and the enabling role of communication technologies in these areas. We report on international negotiations and disseminate knowledge gained through collaborative projects, resulting in more rigorous research, capacity building in developing countries, better networks spanning the North and the South, and better global connections among researchers, practitioners, citizens and policy-makers. IISDs vision is better living for allsustainably; its mission is to champion innovation, enabling societies to live sustainably. IISD is registered as a charitable organization in Canada and has 501(c)(3) status in the United States. IISD receives core operating support from the Government of Canada, provided through the Canadian International Development Agency (CIDA), the International Development Research Centre (IDRC) and Environment Canada, and from the Province of Manitoba. The Institute receives project funding from numerous governments inside and outside Canada, United Nations agencies, foundations and the private sector. International Institute for Sustainable Development 161 Portage Avenue East, 6th Floor Winnipeg, Manitoba Canada R3B 0Y4 Tel: +1 (204) 9587700 Fax: +1 (204) 9587710

Email: [email protected]

Website: www.iisd.org

Moving up the Value

Chain:

Upgrading Chinas

Manufacturing

Sector

Pan Yue

Party School of the Central

Committee of the Communist Party

of China

Simon J. Evenett

University of St. Gallen and Centre for

Economic Policy Research

July 2010

This paper is produced as part of the Sustainable

China Trade Project. The project is a joint effort

of IISD and the Development Research Centre

of the State Council of China, with research

jointly conducted by Chinese and international

experts. It seeks to help define the characteristics

of a sustainable trade strategy for Chinaa

strategy that helps contribute to environmental,

social and economic improvements, primarily in

China but also globally. Such an outcome is in

line with the scientific concept of development

first put forward at the 16th National Congress

of the Communist Party of China in 2003, and

with many of the goals of the 11th Five-Year

Plan. The project will produce a series of eight

working papers focusing on specific aspects of a

sustainable trade strategy for China and a

synthesized volume covering the body of work.

The Sustainable China Trade Project is

generously supported by the Swiss Agency for Development Cooperation.

Moving up the Value Chain: Upgrading Chinas Manufacturing Sector ii

Acknowledgements

The authors gratefully acknowledge the comments and suggestions of participants in workshops

associated with the China Sustainable Trade Strategy project.

Moving up the Value Chain: Upgrading Chinas Manufacturing Sector iii

Table of contents

1.0 Introduction: Upgrading and a sustainable trade strategy for China ................................................. 1

2.0 Domestic and international imperatives for upgrading ....................................................................... 4

2.1. Made in China: Chinas role in global value chains ..................................................................................................... 5

2.2 The international context: Diminishing returns from competing on the basis of low costs ................................... 7

3.0 Upgrading of Made in China: Status quo, opportunities and challenges ...................................... 9

3.1 Upgrading process of the manufacturing industry: A factual overview ...................................................................... 9

3.2 Other economy-wide perspectives on Chinese upgrading ........................................................................................... 15

3.3 Upgrading of specific manufacturing industries ............................................................................................................ 19

3.3.1 Textile and apparel industries ...................................................................................................................................... 20

3.3.2. Electronic and communications equipment .................................................................................................................... 25

4.0 Upgrading opportunities and challenges to the manufacturing industry ........................................ 31

4.2 Challenges confronting the upgrading of the manufacturing industry ...................................................................... 33

4.2.1 Traditional cost advantages are fading away ................................................................................................................. 34

4.2.2 The downside of the localization strategy is becoming more and more apparent .............................................................. 35

4.2.3 Resource availability and environmental concerns are becoming more of a constraint ...................................................... 37

4.2.4 Technological innovation, though impressive to date, must accelerate .............................................................................. 39

4.3. The risks of the status quo and the case for reform ..................................................................................................... 42

5.0 Systems of upgrading: the experience of other countries .................................................................. 46

6.0 Recommendations for accelerating upgrading in a sustainable trade strategy ............................... 50

6.1 Fundamental recommendation ........................................................................................................................................ 50

6.2 A four-point reform agenda to promote upgrading ...................................................................................................... 52

6.2.1 Go all-out to promote technical innovation ................................................................................................................ 52

6.2.2 Promote clean industrial upgrading ........................................................................................................................... 53

6.2.3 Actively promote the localization of the processing trade ................................................................................................ 55

6.2.4 Steadily promote overseas investment............................................................................................................................. 56

References ......................................................................................................................................................... 57

Moving up the Value Chain: Upgrading Chinas Manufacturing Sector iv

List of figures

Figure 2.1 Growth of Chinese exports, 1985 to 2007. Source of data: China statistical yearbooks. ................................................................................................................................ 6

Figure 3.1 Value-added ratio of the Chinese processing trade. ........................................................ 15 Figure 3.2 Total industrial value of Chinas electronic and communications equipment

manufacturing industry (in 100 million yuan). ................................................................. 26 Figure 4.1 Proportions of exports of high-tech products, by ownership of the exporting

enterprise. Source of data: Scientific and Technological Statistics of China, www.sts.org.cn/sjkl/gjscy/index.htm. .............................................................................. 36

Figure 4.2 Proportions of exports of high-tech products, by source of material. Source of data:

Scientific and Technological Statistics of China, www.sts.org.cn/sjkl/gjscy/index.htm. .............................................................................. 36

List of tables

Table 3.1 Top five industries contributing to industrial added value in different years. Source of data: China statistical yearbooks. ................................................................................... 10

Table 3.2 Technological intensity level of the Chinese manufacturing industry, as percentage of

total. Source of data: China statistical yearbooks. ............................................................ 11 Table 3.3 Proportion of Chinese heavy industry by sector, as percentage of total. Source of

data: China statistical yearbooks. ........................................................................................ 11 Table 3.4 Top five industries contributing to the added value of foreign-funded enterprises.

Source of data: China statistical yearbooks. ...................................................................... 13 Table 3.5 Composition of Chinese exports, as percentage of total. Source of data: Statistical

data of customs. .................................................................................................................... 14 Table 3.6 Major economic indicators of foreign-funded firms in the textile and apparel

industry, percentage of respective industry totals. The reported figure for the proportion of total profits in 1995 is in fact the proportion to total profits and taxes. Source of data: China statistical yearbooks. ...................................................................... 21

Moving up the Value Chain: Upgrading Chinas Manufacturing Sector v

Table 3.7 Chinas share of world textile and apparel production. Source of data: http://www.wto.org............................................................................................................. 21

Table 3.8 Percentage of major industry-wide indicators in electronic and communications

equipment manufacturing accounted for by foreign-funded enterprises. The reported figure for the proportion of total profits in 1995 is in fact the proportion to total profits and taxes. Source of data: China Statistical yearbooks. ...................................... 26

Table 3.9 R&D intensity of electronic and communications equipment manufacturing

industries in various countries and years. Here R&D intensity is the ratio between R&D expenditures and the total added value of the industry. Source of data: www.sts.org.cn, Statistics of Chinese High-Tech Industries. ......................................... 28

Table 4.1 R&D intensity of manufacturing and high-tech industries, various countries and

years. R&D intensity is the ratio between R&D expenditures and the added value of the industry. Source of data: Statistics of Chinas High-Tech Industries, www.sts.org.cn. ..................................................................................................................... 40

List of acronyms

ASEAN Association of Southeast Asian Nations

FTA free trade agreement

G20 20-Nation Coordination Group

LDCs least developed countries

WTO World Trade Organization

Moving up the Value Chain: Upgrading Chinas Manufacturing Sector 1

1.0 Introduction: Upgrading and a sustainable trade strategy for

China

The development process is often viewed as involving a series of transformations of a countrys

economy, societal relations and governance. One of the most prominent manifestations of

development is the shift from widespread employment in agriculture into a fast-growing, jobs-

intensive manufacturing sector. China has been able to pull off this particular transformation with

impressive speed. While some of Chinas neighbours (Korea and Taiwan province) saw faster

growth of value-added manufacturing during their first 30 years of takeoff,1 the sheer scale of

Chinas industrial development has been unique.

That scale, however, has had implications for Chinas use of natural resources, for the degree of

harmony in international trade relations and, ultimately, for the case for China modifying its

development trajectory. The relatively intensive use of resources and energy by Chinese

manufacturing firms is said to have put pressure on worldwide commodity prices, though in fact it is

total demand for commodities that influences prices, not any one source of demand. The growth of

manufacturing exports from China has caused alarm in many trading partners, both industrialized

and developing, as Chinese products compete directly with foreign firms in the latters home and

export markets. Plus, there is dissatisfaction from some quarters within China at the pace with which

its firms are developing their own products, brands and innovative capabilities. Together these

concerns have helped put the subject of upgrading by Chinese firms on policy-makers agendas.

Having assessed the degree of upgrading by Chinese manufacturing firms and contrasted the

Chinese experience with that of its trading partners, the purpose of this paper is to identify the

challenges faced by Chinese firms in upgrading and the possible policy responses to those

challenges. Since this paper is part of a larger project that seeks to flesh out a so-called sustainable

trade strategy for China, it is worth recalling what the five objectives of that strategy are:

1. Promote the rebalancing of the Chinese economy away from its currently unsustainable

path.

2. Promote added value in economic activities, not just sales.

3. Promote services, not just manufacturing.

4. Nationality matters; therefore, promote Chinese firms (including multinationals), brands and

intellectual property rights.

5. Support a harmonious, sustainable architecture for international trade.

1 See Brandt, Rawski and Sutton (2007, fig. 15.1), for evidence. This chart also shows that in the first 30 years of the countrys takeoff , the expansion of Japanese value-added in manufacturing was slower than that in China.


Arguably, upgradingto the extent that it results in more sought-after products made by Chinese

firms, higher levels of production-process efficiency (which in turn is related to lower resource use)

and other process innovations, and organizational improvementscan help meet all five of the

above goals.2 More efficient resource use helps attain the first goal. Product improvements, often the

result of combining goods with services, help with the second and third goals. To the extent that the

benefits of upgrading by Chinese firms are realized by those firms in the form of higher profits, the

fourth goal is advanced. Reduced tensions with trading partners, especially those producing low-end

manufacturing goods, may also be a payoff from upgrading, advancing the fifth goal.3 These are the

potential payoffs; what this paper aims to do is shed light on what the state can do to facilitate such

upgrading.

At this stage it is important to distinguish between the manifestations of upgrading (product

innovations, process innovations, more efficient resource use) and upgrading itself. In their review

overview of Chinese industrial development, Brandt, Rawski and Sutton (2007) drew a contrast

between the revealed capabilities of a firmthat is, the range of products that it currently

produces, the unit costs of production (including resource use intensity) and the perceived quality of

the product as manifested by the willingness of customers to pay for the productand the

underlying capabilities of a firm. The latter include the know-how that is collectively held by the

firms employees and the capacity to spot and take advantage of new opportunities as demand and

technology change. This distinction is useful, as it forces analysts to focus on how firms and

managers acquire, develop and retain underlying capabilities and the on capacity to successfully

employ those capacities, along with other firm resources, to improve the firms revealed capabilities.

Of course, it is not the firm that acquires, develops and retains underlying capabilities, but rather the

firms owners and managers. This raises a subtle point about the skills of these owners and managers

and the basis upon which firms are competing. Ultimately, upgrading may require substantial

changes in the very basis upon which a firm operates. Rather than continuing to compete on the

basis of low production costswhich requires a certain set of managerial skillsupgrading is going

to require acquiring expertise and the capacity to manage that expertise. The very role of a manager

has to change, and this may not be something that the traditional tools available to governments can

do much to influence. Indeed, government policy is likely to play an indirect role here, as the

principal decisions are made by firm managers and owners, both in China and elsewhere. Certainly,

2 We make no claim that upgrading alone is the only step necessary for China to attain all five goals. Other papers in this project explore the various contributions of state and non-state actors to the goals of a sustainable trade policy. 3 Although, to the extent that Chinese firms begin producing higher-value-added goods that compete more intensively with goods and services produced in industrialized countries by persons with moderate or high skill levels, then in principle, trade frictions with those countries could increase. Many factors are likely to determine the severity of trade frictions between two countries. One factor that may mitigate trade frictions is whether each partys own commerce and

markets for corporate control are in fact open to competition from another partys firms. Much will depend on policy-makers weighing of the ability to compete with the outcome of such competition.


governments may offer financing and subsidies and establish institutions to enforce intellectual

property rights, but they cannot directly upgrade firms.

Another important point is an appreciation of the motive for upgrading. Assuming that upgrading is

desirable, it is useful to ask what market mechanisms and policies are most conducive to stimulating

the effort and the expertise required to upgrade. Moreover, as the benefits of upgrading are typically

not reaped immediately, then policy-makers need to give thought to the procedures that will ensure

the commercial payoff from upgrading is sufficiently large. Taken together, then, the principal

linkages are among government policy, the market environment facing a firm (including the

protection of intellectual property rights and the enforceability of contracts), the incentives of

managers and owners (given the many factors influencing the market environment), the capabilities

of firms and the manifestations of upgrading. As will become clear, different analysts emphasize

different links among these factors. Even so, at least in principle, analysts and decision-makers

should be open to the fact that there may be several recipes for success and therefore, perhaps,

menus of options for Chinese policy-makers.

The rest of this paper is organized as follows: Section 2 examines the domestic and international

imperatives for upgrading, making a particular link to the context of the expansion of global value

(supply) chains in recent years. Section 3 provides a detailed overview of the current upgrading of

Chinese manufacturing firms, identifying corporate opportunities and four related challenges faced

by Chinese firms. We present two industry studies, one for the textile and apparel sector and the

other the electronic and communications equipment sector. We then discuss international

experience with respect to corporate upgrading in Section 4. We describe the state measures that can

promote industrial upgrading, as well as some principles to guide decision-makers, in Section 5.


2.0 Domestic and international imperatives for upgrading

Since the 1980s, fierce competition in global markets has pushed multinationals into adopting a new

business strategy, creating one sizeable and ongoing opportunity for firms in developing countries to

upgrade.4 By formulating unified design rules and technical standards, multinationals broke up the

entire production and operation process into a number of value-added links such as product design,

procurement, production of components and intermediate goods, processing and assembly, training,

sales, and research and development. Then, through direct investment and outsourcing, the

independent and closely interrelated value-added links were deployed in the most appropriate

regions around the world, thereby forming a global value chain in the industry.5 The globalized

deployment of industrial chains has resulted in the enormous enhancement of the efficiency of

modern industries and the rapid development of the competitiveness of core enterprises. Such a new

business strategy quickly came into extensive use in all industries, including both labour-intensive

industries that make garments, shoes and hats and the capital- or technology-intensive industries of

auto-making and communications, and including both manufacturing industries and service

industries.

The expansion of global value chains has provided a new option for the industrial growth of

developing countries. By introducing foreign capital and by outsourcing, developing countries can

integrate with the global industry chain, starting from the link of processing and assembly at the

lowest end and gradually moving up toward the links of high added value, such as upstream

manufacturing and research and development and downstream sales, through continuous capital

accumulation and technological progress. This is a new route, whereby the developing countries can

achieve industrial growth and upgrading against the background of globalization. In 1970s the Asian

Four Small Dragons accelerated their industrialization process and realized economic prosperity

through such integration with global value chains. Since the 1990s, as the largest undertaker of the

transfer of the global manufacturing industry, China has become a base of global manufacturing and

created a wonder of international trade and economic growth.

4 It would be wrong, however, to conclude that upgrading in developing countries would have not happened in the absence of the development of global supply chains. As will become clear later, one school of thought argues that the integration of the national market in China (that is, the gradual removal of interprovincial trade barriers) facilitated intensified competition between Chinese firms and promoted upgrading too. 5 For the development of global value chainsor global production networks, as some prefer to refer to themsee Hess and Yeung (2006). This paper summarizes much recent research on global production networks, including the relationship to upgrading. In this regard Hess and Yeung argue that various aspects of the business environment in which multinationals operate in developing countries influence how much local value-creation and upgrading takes place. Moreover, they argue that the lessons for China from other developing countries may be limited by the fact that the former is seen as must invest location for multinational investment.


The expansion of the global value chain has posed challenges to the industrial growth of developing

countries. On the one hand, by leading technological innovations and systemic change,

multinationals are gradually concentrating most of the added value of the entire value chain into the

core links and continuously slashing the total profits to be made along the manufacturing chain. On

the other hand, through outsourcing and original equipment manufacturing, more and more

developing countries are squeezing into the low-end links of the industry chains, creating intense

competition that has placed the developing countries involved in the links of processing and

manufacturing under unprecedented pressure to upgrade. Moreover, the international transfer of the

low-end manufacturing industry is often accompanied by the transfer of high pollution, high energy

consumption and high raw material consumption as well as causing frequent trade frictions.

Therefore, although the pursuit of clean upgrading and sustainable trade growth are the important

tasks of developing countries, they tend not to be seamlessly accomplished.

2.1. Made in China: Chinas role in global value chains

Since the inception of reform and associated opening up to the world economy, China set out on

the development route of international industrial transfer by enthusiastically introducing foreign

capital and working hard to develop foreign trade. Thanks to Chinas abundant, high-quality and

low-price labour resources; a potentially huge domestic market; preferential policies for foreign

capital and foreign trade; and a stable political and social situation, China has gradually become one

of the largest global destinations of direct foreign investment. From 1979 to 2007 China

cumulatively introduced several hundred billion U.S. dollars of direct foreign investment, of which

70 per cent went into the manufacturing industry, which mostly consists of the processing and

manufacturing links in the global value chain. The concentration and development of the global

value chains of all industries, including the high-tech industry, on the eastern coast of China have

boosted the sustained, rapid growth of Chinese exports and caused a marked improvement in the

countrys export makeup, resulting in China becoming a base of manufacturing industry and

capturing global attention (the so-called Made in China" phenomenon). As can be seen In Figure

2.1, since the mid-1990s the processing trade (of parts, components and raw materials) has

accounted for half of the Chinese export trade, and foreign-invested enterprises have become an

important force propelling Chinese exports. This adequately reflects the aggregation and expansion

of the processing and manufacturing links of the global industrial value chain in China and shows

that the development of the Chinese manufacturing industry has merged deeply with the global

value chain and the system of international division of labour.


Figure 2.1 Growth of Chinese exports, 1985 to 2007. Source of data: China statistical yearbooks.

However, many surveys and studies have shown that, in spite of the noticeable differences among

different industries and regions, Made in China still lies among the low-end links of the global

value chain for most industries, which carry out processing and manufacturing activities of lower

added value. This phenomenon finds expression in the fact that not only are over two-thirds of

Chinese processing trade enterprises still engaged in labour-intensive production and processing but

also that the added value of most Chinese manufacturing industries is far below that of developed

countries. For quite a long time, the share of value-added in the processing trade has remained

around 50 per cent. Besides, under Chinas mode of extensive economic growth, the expansion of

the manufacturing industry has further projected the negative effects brought by international

industrial transfer, and China has become one of the global regions with the worst environmental

pollution. As its gains from the division of labour on the global value chain are falling and the profit

space of its enterprises continues to dwindle, China faces intensifying international trade frictions,

increasing risks of internal-external economic imbalance and grave challenges to the sustainability of

its economic growth.

It has always been a policy objective of the Chinese central government and of local governments to

promote the technological progress of enterprises and expedite industrial upgrading so as to increase

the gains from the division of labour in the global value chain. Under the guidance of the new

0

2000

4000

6000

8000

10000

12000

14000

1985 1988 1991 1994 1997 2000 2003 2006

Total Export of China Export of Foreign-invested Enterprises Export of Processing Trade


concept of developmentsustainable developmentChina has developed an even more clear-cut

policy orientation toward new industrialization and lifting the position and role of Made in China

on the global value chain. Therefore, the achievement of clean upgrading and sustainable

development is becoming an integral part of promoting the good and rapid development of the

national economy (Hu, 2007). Since the beginning of the new century the shortage of labour has hit

the Pearl River delta and the Chang Jiang River delta; the unlimited supply of labour has materially

changed; the price of energy and other elements has risen sharply; and Chinas traditional low-cost

advantage has begun to trail off.

In addition, as the incomes of Chinese private consumers have risen, so has the demand for higher-

quality domestically made products. The days when consumers would buy anything that firms chose

to make are coming to a close. Managers must therefore learn what customers want and keep

abreast of the changing tastes of potential buyers, in particular those willing to pay higher prices.

Once a firm has spotted new consumer trends, it must also have staff who can develop new

products and bring them to market expeditiously and within budget. Competition on the basis of

time to market requires a broader range of managerial skills than has hitherto been necessary.

In the meantime, the environmental protection standards for all industries have been raised

continuously and are progressing steadily. After nearly three decades of reform and opening, China

is feeling urgent internal pressure for upgrading, which requires Made in China to move up along

the global value chain toward upstream and downstream processes while lowering resource and

energy consumption so as to realize environmentally friendly, clean development. For a large

developing country in transition, this will be a difficult takeoff.

2.2 The international context: Diminishing returns from competing on the

basis of low costs

The upgrading of Chinese manufacturing firms should be seen in the context of disparate foreign

commercial and political dynamics. Collectively, effective competition from Chinese firms in the

manufacture of low-tech products and the assembly of goods has put considerable pressure on the

profits and employment levels of firms in developing and industrialized countries. This has

manifested in a growing number of trade disputes and trade-defence measures against Chinese

exports (see Evenett and Li, 2010, also from this project, for more details). One suggested response

to these pressures is for Chinese firms to upgrade their product offerings, thereby, so the argument

goes, relieving the pressure on low-skilled workers abroad and the associated protectionist pressure.

(Whether calls for trade restrictions on Chinese products would in fact decrease after Chinese firms

had upgraded and were competing directly with mid- to high-tech firms and their employees is

another question.)


Another important consideration facing Chinese firms is that, in some sectors, they face low-wage

competition from nearby neighbours in the Greater Mekong subregion. Ultimately, in many Chinese

manufacturing sectors, competition based on low costs is probably not sustainable.6 Firms need to

innovate in their product offerings and processes to keep one step ahead of rivals, so the very basis

of competition between firms must evolve. Moreover, cutting Chinese wages or not sharing enough

of any productivity increases with workers is a recipe for social instability, and therefore it is not

surprising that some advocate upgrading Chinese products so as to raise both long-term living

standards and the competitiveness of Chinese industry.

Historically, of course, much has been made of the so-called flying geese characterization of export

patterns and associated upgrading within East Asia, with Japan being the first goose to set off on

this trajectory. Seen in this light Chinese upgrading is part of a long-established trend within the

region. However, the very scale and growth of the Chinese manufacturing sector, with its impact on

world markets, is distinctive. Indeed, it has been argued that because of Chinas export growth, some

trading partners are reluctant to lower their tariff barriers in the Doha Round of multilateral trade

negotiations.

In addition to pressure from firms that compete with imports and from the governments they

complain to, other potential partners for Chinese companies that are headquartered in industrialized

countries may demand as part of their collaboration that their Chinese counterparts improve their

product offerings and production and organizational processes. Upgrading may thus become a more

prevalent prerequisite for Chinese corporate engagement in higher-value-added, collaborative

initiatives. More generally, to the extent that broad-based upgrading leads to increased national

productivity levels, living standards can improve in China and the nexus between export growth and

national economic growth will likely strengthen.

The international context reinforces domestic dynamicsincluding those created by governmental

priorities for cleaning up the environment and the more demanding aspirations of Chinese

consumers for better productsand points to the need for upgrading. The question arises as to how

such upgrading can be done, whether policies to foster upgrading exist and whether upgrading can

be undertaken in a way that is consistent with the other development objectives of the Chinese

central government. Much of the rest of this paper seeks to shed light on these matters.

6 A January 2008 report by the Boston Consulting Group examined the factors underlying the overseas expansion strategies of the 100 largest internationally active firms headquartered in developing countries (Boston Consulting Group, 2008). The authors of the study found that in only 14 per cent of cases did the firms overseas expansion strategy turn principally and solely on low-production-cost advantages. The remaining 86 per cent of firms expected to compete principally on some other basis. This is not to imply that low production costs are not important for a firm, just that for many of the developing worlds multinationals, low cost is not the expected basis for competition in international markets. Low production costs may well reflect efficient resource use and, if so, are desirable from the perspective of sustainable development. Finally, it is worth noting that 40 per cent of the 100 firms examined in the Boston Consulting Group study were Chinese.


3.0 Upgrading of Made in China: Status quo, opportunities and

challenges

In the first part of this section we present raw data on Chinese manufacturing sectors to provide an

indication of the degree to which Chinese firms have upgraded. Recall that upgrading is a firm-

specific process that takes place over time and ultimately manifests itself in terms of the types of

products a firm offers to sell, whether those products are combined with services, a firms costs or

its productivity growth. This is important for a number of reasons. First, ideally, firms need

information on the inputs associated with upgradingsuch as managerial effort, skill acquisition and

deploymentnot just outputs that are potentially affected by a decision to upgrade. Second,

upgrading can impact many indicators of firm performance, so firms must be cautious about

drawing too many inferences from any one indicator. Third, in a perfect world, decision-makers

would like to know the effect on a group of performance indicators of different upgrading decisions

made by managers and, ultimately, the link between policy instruments and those upgrading

decisions. Unfortunately, information on the latter linkages is rarely available, and analysts often only

have piecemeal information on the various relevant causal factors.

3.1 Upgrading process of the manufacturing industry: A factual overview

Since the turn of the century the manner in which Chinese manufacturing firms are upgrading has

become clearer. Such upgrading was initially represented by the rapid growth of the heavy and

chemical industries (including steel, machinery and chemical engineering, and technology-intensive

industries such as electronics and communication equipment). According to available statistics,

heavy industry has grown faster than light industry. By 2006 the percentage of total industrial output

represented by the heavy and chemical industries had reached 70.04, while that of light industry had

dropped to 29.95. While the proportion represented by traditional industries has declined, the

tendency toward heavy industrialization has strengthened continuously. Some industries, such as

precision machinery and specialized equipment, are also showing a trend of accelerated

development. The rapid growth and increasing driving force of these industries will undoubtedly

further speed their structural adjustment and upgrading. Table 3.1 lists the top five industries

contributing to industrial added value in different years. As can be seen from the table, compared

with 1995 the proportion represented by the textile industry has gone down gradually since 2000,

while the proportion of technology-intensive industries, such as chemical industries and the

electronic and communications equipment industry, went up. By 2003, as the textile industry

dropped out of the top five, the technology-intensive industries had built up to become the leading

industries and an industrial group that was growing rapidly in a new round of a boom cycle.

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Table 3.1 Top five industries contributing to industrial added value in different years. Source of data: China

statistical yearbooks.

Rank Year

1 2 3 4 5

1995 Industry

Ferrous-metal smelting & rolling

Chemical raw materials & chemical product manufacturing

Oil & natural gas extraction

Nonmetal mineral products

Textiles

Proportion (%) 6.82 6.10 6.08 5.82 5.81

2000 Industry


Electronic & communications equipment manufacturing


Transport equipment manufacturing

Textiles

Proportion (%) 8.70 7.18 5.57 5.21 5.01

2003 Industry






Proportion (%) 8.29 6.90 6.73 5.87 5.69

2006 Industry






Proportion (%) 7.74 7.66 6.54 5.90 5.39

In contrast with the heavy industrialization based on raw materials in early 1990s, more recent

industrial growth has tended to be in more technologically sophisticated sectors and to involve

processing activities. Table 3.2 shows the shift in production toward Chinese industries with greater

technological intensity, with industries classified based on an OECD scheme. Comparing the data

for 2006 with that for 1995 reveals that the contribution to industrial added value made by the low-

or medium-tech industries decreased gradually, while that made by medium-high and high-tech

industries increased, especially for the latter industries. Table 3.3 shows the changes in the

distribution of added value made by the components of the chemical industry. According to the data

in the table, from 1995 to 2003 the mining industrys proportion of heavy industry dropped by 4.58

percentage points, that of the processing industry rose by 4.84 percentage points and that of the

intermediate category, raw materials, fell slightly. The ratio between these industries was 1 to 2.1 to

2.1 in 1995, compared with 1 to 2.77 to 3.09 in 2003, which reflects the upgrading of Chinese

industries in the direction of greater processing. Influenced by the changes in world prices of energy

and raw materials, the size of the mining industry rebounded dramatically in 2006, and that of the

kwsamwong


processing industry went into reverse. As a whole, Chinese manufacturing industries have

continuously improved in technological capability and processing depth.7

Table 3.2 Technological intensity level of the Chinese manufacturing industry, as percentage of total. Source

of data: China statistical yearbooks.

Year Low-tech Low-medium-tech Medium-high-tech High-tech

1995 44.13 25.50 20.85 9.52

2000 47.34 19.75 20.10 12.81

2006 42.58 22.82 21.25 13.35

Table 3.3 Proportion of Chinese heavy industry by sector, as percentage of total. Source of data: China

statistical yearbooks.

Mining Raw materials Processing

1995 19.16 40.57 40.26

2000 19.82 39.12 41.06

2003 14.58 40.32 45.10

2006 18.14 40.61 41.25

Structural upgrading has also occurred as multinationals have moved into a new phase of their

industrial transfer toward China. In pace with the rapid growth and restructuring of the Chinese

economy, multinationals have adjusted their strategy of investing in China and changed the industrial

makeup of their transfer into China. Since Chinas accession to the WTO, multinationals around the

world have expanded their operational objectives in China and integrated their business operations

there by introducing into China the upstream research and development, design and manufacturing

of core components and intermediate products, as well as downstream sales and logistics.

According to published government statistics, since 2000 substantial foreign investment has been

made in industries that manufacture electronic and communications equipment, transport

equipment, electrical appliances and apparatuses, general-purpose equipment, and chemical raw

materials and chemical products, in contrast with a dwindling flow into light textiles and other

labour-intensive industries. Meanwhile, investment in research and development has been on the

rise. By the end of 2006 over 980 R&D centres had been set up by multinationals in all forms. A

new pattern has unfolded that features an obvious upstream and downstream extension of the

industrial chain in China. China is becoming an important provider of new technologies and new

7 Similar evidence, based on indexes of revealed comparative advantage, can be found in Bennett, Vaidya and Liu (2007). These authors conclude that from 1987 to 2005, Chinese exports shifted toward more medium- and high-tech sectors, notably in electronics and electrical products and in telecommunications. The authors recognize that the rate of technological improvement inevitably varies across firms and sectors, but they are not as pessimistic as some observers (such as Nolan, 2001). It is also possible to compare Chinese export performance in higher-tech sectors with that of other developing countries. Once such analysis, which presents evidence of faster upgrading of Chinese exports compared with Mexican rivals, can be found in Gereffi (2009). This paper considers the pattern of exports from China and Mexico to the United States, a market that both countries exporters actively contest.


products, and the Chinese manufacturing industry has begun to shift from a base of processing and

assembly to a base of production, procurement, and research and development.

Table 3.4 lists the top five industries contributing to the industrial added value of foreign-funded

enterprises in different years. As can be seen from the table, since the mid-1990s the manufacturing

of electronic and communications equipment has been the largest contributor to the industrial

added value of foreign-funded enterprises, reflected in a proportion that has risen each year to reach

21.43 per cent in 2006. At the same time, the textile and apparel industries fell back in the ranking

until they dropped out of the top five in 2006, compared with the strong buildup in the electrical

appliance and transport equipment manufacturing industries. By 2006, capital- and technology-

intensive heavy- and chemical industries occupied all of the top five places, and the ratio of their

contribution to the industrial added value of foreign-funded enterprises reached as high as 47.18 per

cent. A comparison of Table 3.4 with Table 3.1 shows that they are nearly the same, consistent with

a significant contribution from international transfer of technology and managerial practices to the

industrial upgrading of China.


Table 3.4 Top five industries contributing to the added value of foreign-funded enterprises. Source of data:

China statistical yearbooks.

Rank

Year 1 2 3 4 5

1995 Industry

Electronic &

communicatio

ns equipment

manufacturing

Transport

equipment

manufacturing

Textiles Apparel &

other fibre

product

manufacturing

Electrical

appliance &

apparatus

manufacturing

Proportion (%) 14.44 7.32 7.05 6.72 5.39

2000 Industry

Electronic &

communicatio

ns equipment

manufacturing

Electrical

appliance &

apparatus

manufacturing

Transport

equipment

manufacturing

Chemical raw

materials &

chemical

product

manufacturing

Apparel &

other fibre

product

manufacturing

Proportion (%) 19.59 6.92 6.70 5.01 4.75

2003 Industry

Electronic &

communicatio

ns equipment

manufacturing

Transport

equipment

manufacturing

Electrical

appliance &

apparatus

manufacturing

Chemical raw

materials &

chemical

product

manufacturing

industry

Textiles

Proportion (%) 20.90 11.13 6.15 5.33 3.97

2006 Industry

Electronic &

communicatio

ns equipment

manufacturing

Transport

equipment

manufacturing

Electrical

appliance &

apparatus

manufacturing

Chemical raw

materials &

chemical

product

manufacturing

General-

purpose

equipment

manufacturing

Proportion (%) 21.43 9.14 6.67 6.07 3.87

The change in the profile of Chinas exports of goods is the most direct reflection of structural

upgrading. Since the beginning of the new century, the upgrading of the industrial structure has

found a vivid expression in the export structure of China. As shown in Table 3.5, from 2000 to 2006

the export proportion composed of primary products fell from 10.2 per cent to 5.5 per cent,

compared with an increase in the export proportion of industrial products from 89.8 per cent to

94.5 per cent. The most prominent expression of the changes in export structure is the sharp rise in

the proportion of exports that is made up of mechanical and electrical products and high-tech

products. The proportion of exports composed of mechanical and electrical products rose from 42.3

per cent in 2000 to 56.7 per cent in 2006, accounting for more than half of total exports. The

proportion composed of high-tech products rose even faster during this period, from 14.9 per cent

to 29.1 per cent. Since a large portion of exports are conducted by foreign-funded enterprises


through the processing trade, the structure of export products is insufficient to support a judgment

about the position of Chinese industry in the global chain of industries. Nevertheless, the transition

of the export-product makeup from traditional, labour-intensive products to technology-intensive

products indicates that Made in China has upgraded successfully between different types of

industries.

Table 3.5 Composition of Chinese exports, as percentage of total. Source of data: Statistical data of customs.

Classification

Year

Primary

products

Finished products

Total Mechanical & electrical High-tech

1995 14.4 85.6 29.5 6.8

2000 10.2 89.8 42.3 14.9

2003 7.9 92.1 51.9 25.2

2006 5.5 94.5 56.7 29.1

Since 2005 the imperative to upgrade has strengthened due to soaring production costs in coastal

regions and a series of government policies. The Pearl River delta is where foreign-funded

enterprises settled when they first entered mainland China and also where the labour-intensive

industries and the links of processing and assembly, such as of garments, shoes, hats and toys, have

concentrated. In recent years, however, traditional labour-intensive enterprises have begun to

relocate as a result of the constant rise in wages and land cost as well as in the standards for

environmental and labour protection. In the city of Dongguan, in 2007 alone 15 per cent of

shoemaking enterprises were closed down or relocated (Mitchell, 2008). They moved part of their

production lines or processes either to hinterland provinces such as Jiangxi or to Southeast Asian

countries such as Vietnam. Still, most of the enterprises have chosen to stay because of the first-rate

infrastructure in the Pearl River delta, skilled labour force, tight-knit upstream and downstream

supply chains, and an enormous market. They also try to meet the challenges of rising costs, trade

frictions and appreciation of the Chinese yuan by enhancing productivity and optimizing production

modes.

In the meantime, the shifting out of low-end industries has provided space for the shifting in of

mid- to high-end industries. In Dongguan the shortage of land made it impossible for over 100

foreign-invested projects to move in during the first half of 2006. These industries involved a total

of US$2.8 billion (Chen, 2006). The shift out of traditional industries, such as shoe and hat

manufacturing, is no doubt a precondition for the entry of high-tech enterprises. Also, according to

statistics, in 2007 China absorbed US$74.8 billion of direct foreign investment, registering a year-

over-year rise of 13.6 per cent. During the same period, the number of newly established foreign-

funded enterprises was 37,888, a year-over-year fall of 8.69 per cent. While the influx of capital

increased, the number of newly established foreign-funded enterprises decreased. This is proof that

the influx of foreign capital has not been entirely stifled by rising costs. Instead, the quality of the


new influx of foreign capital is improving steadily, for foreign-funded projects of large scale and

high added value are gradually becoming mainstream. The value-added ratio of the processing trade

is an indicator that measures the added value created by an industry and indirectly reflects the

upgrading status of the industry on the global value chain. From Figure 3.1 we can see clearly that

after nearly eight years of hesitation from 1998 to 2005, the value-added ratio of the Chinese

processing trade began to manifest a marked upward trend in 2006 and 2007. This is a new change

in the processing trade, which occurred after production costs started their uphill climb, and

presents an optimistic prospect for the upgrading of Chinese processing trade.

Figure 3.1 Value-added ratio of the Chinese processing trade.

3.2 Other economy-wide perspectives on Chinese upgrading

Here we summarize other, economy-wide evidence on the extent of and factors determining

upgrading by Chinese manufacturing firms. Our starting point is the recent, detailed overview of

Chinese industrial development found in Brandt, Rawski and Sutton (2007), three leading scholars

of either the Chinese economy or the behaviour of firms in developing countries. These authors

argue that starting from the late 1970s, liberalization and market expansion arising from the gradual

demise of planning, the relaxation of control over international trade and investment, and

improvements in transport and communication stimulated entry into formerly closed markets,

intensified competition, and deepened market integration (p. 576).

In the authors view, intensified competition provides the incentives managers need to upgrade

production processes and products. Put another way, beyond the intensification of competition

through reforms, these authors give little credit to state policies for fostering upgrading. They accept

that circumstances differ across industries and sectors, and therefore that the response to greater

80

70

60

50

40

30

20

10

0 1995 1996 1997 1998 1999 2000 2002 2001 2003 2004 2005 2006 2007

Value-added Ratio of Processing


competition is not always the same. Indeed, Brandt et al. argue that industry-specific factors are

likely to be important enough that Chinese firms upgrading will ultimately follow that seen in other

countries (p. 570).8

In general, Brandt et al. argue greater competition has three effects on firm performance and

upgrading. The first is that greater competition puts downward pressure on prices, and the least

capable firms are less likely to be commercially viable. Pressure to upgrade production processes so

as to lessen costs would then follow from this intensification of competition. Failure to improve

performance leads to firm exits and to consolidation within the sector. Second, firms intensify

research and development expenditures in response to greater competition and the ensuing

shakeout. The goal is to enhance the very capabilities defined in the introduction to this paper as

being central to the notion of upgrading. Third, shocks to the market environment, brought about

by changes in competitive pressure but presumably also other sources, can sometimes reveal a gap

between a firms current revealed capacities and its underlying dynamic capacities. When this gap

emerges, the firm may lose market share, and its future may be in jeopardy. From this perspective,

competition and the upgrading it induces are likely to produce substantial changes in market shares

(and perceived market leadership among firms.) This outcome is, the authors argue, not anomalous

or perverse, even if it is likely to lead to job loss and dislocation.

Brandt et al. (2007) point to several indicators of upgrading by Chinese firms. At the end of 2005

nearly 144,000 firms had met International Organization for Standardization standards, up from

around 7,500 in 2001 (p. 616). Defect rates in industries subject to international benchmarking, such

as automobiles, have fallen considerably. Detailed analyses of patterns of Chinese exports to

demanding overseas markets such as the United States show breakthroughs into higher-quality

product market segments (they cite the research of Schott, 2008, and Hallak and Schott, 2008.) They

note the growing qualitative evidence connecting these positive developments to various

international linkages developed by Chinese firms, including participation in value chains and the

foreign direct investments along the Eastern seaboard (pp. 623624). Still, the situation could

improve. Research and development expenditures as a share of sales are still relatively low. More

generally, however, the authors argue that the gains of high-performance firms cluster within the

realm of production: industry has recorded much smaller advances along other segments of the

industrial value chain, including R&D, design, product development, branding, and management of

supply networks (p. 624).

These authors explore this logic for a number of fast-growing Chinese manufacturing sectors. These

sectoral accounts do not give much (if any) weight to positive government interventions to promote

upgrading. It is not that these authors deny that there has been substantial intervention in various

8 This suggests that there will not be a particular Chinese approach to upgrading. Presumably this claim relies on the implicit assumption that the principal determinant of upgrading in the Chinese case remains competition and not a specific set of policies tailored to Chinese circumstances.


sectors (pp. 623624). On the contrary, they criticize government measures to cushion (offer

financial support to) less successful firms, for example, in the case of televisions (p. 586). They say,

Official efforts to shield client firms and their employees from the rigors of the market

competition, though diminishing, continue to obstruct the process of upgrading by blunting

incentives and prolonging the lives of uncompetitive firms (p. 624).

In sum, Brandt et al. put competitive pressure and international linkages at the heart of their

explanation for the current extent of Chinese upgrading, though one could argue that competition

for international linkages is another form of competitive pressure. As will become clear in a later

section of this paper, this perspective is consistent with Michael Porters (1990) account of the

factors that determine upgrading and innovation by firms.9

Further information on the extent and form of innovation by Chinese manufacturing firms, and on

impediments to such innovation, can be found in the recently published study by Alcorta, Urem and

Tongliang (2008). This study reports the results of a professionally conducted survey of a sample of

manufacturing firms located in Jiangsu Province. The survey instrument was based on that used by

the European Commission and the Organisation for Economic Co-operation and Development. In

this survey, innovation was defined as the commercial introduction of new products and

processes, and therefore the paper focused on improvements that were brought to market. To

provide a comparator, the survey was also put to firms that had not been successful in innovating

(what the authors referred to as non-innovators). The authors distinguished between radical

innovation, which involves a transformed design, profound changes in the technical characteristics

and features, alternative inputs or components and/or creating different uses or applications for a

good, and incremental innovation, which involves adaption, enhancement or upgrading in design,

technical characteristics, use of inputs and components and applications of the good (p. 562). The

third major modification of the survey was to determine the degree of novelty of the innovation.

Innovations were, therefore, classified as new to the world, indicating a high degree of novelty, or

new to the firm, a lower degree of novelty.

With respect to the degree of innovation, Alcorta, Urem and Tongliang found that 91.3 per cent of

surveyed firms claimed to have introduced some form of innovation. Just over 80 per cent claimed

to have introduced both process and product innovations. Around one-eighth claimed to have

introduced only product innovations, and 6.8 per cent claimed to have introduced only process

innovations. Three-fifths of sales were associated with products that had undergone incremental

innovation, providing one indicator of the relative importance of incremental versus radical

9 These findings are consistent with those a study that employed a very different economic methodology. Jefferson, Rawski and Zhang (2007) used standard econometric techniques to assess, among other matters, the productivity dynamics of Chinas largest manufacturing firms over the years from 1998 to 2005. They found that the entry and exit of

firms, a consequence of the competitive process, was a significant contributor to the improvement in industry productivity levels and the convergence across Chinese regions in productivity levels of firms in the same sector.


innovation. Innovations concerning established products accounted for three-fifths of sales too.

Only 4 or 5 perc ent of innovations by the surveyed firms were new to the world;10 between 8 and

12 per cent were new to China or to Jiangsu Province. About 15 per cent of product and process

innovations were new to the firms themselves (pp. 565 & 566, Tables 1 & 2). The authors argued

that, despite the inevitable difficulties in making international comparisons of innovation based on

firm-level surveys, the Jiangsu Province innovation survey showed that the extent of innovation in

Chinese firms compared favourably with those in many industrialized and developing countries (for

which they cite comparable percentages). They also noted that the most common form of

innovation found in the survey was of the catching up type (that is, adopting innovation closer to

best practice as opposed to defining new best practice).

The survey also considered the motives for innovation and examined whether any significant

differences existed between innovating and non-innovating firms. They succinctly summarize their

findings thus:

By and large, the most important objective underlying innovation is to improve

general competitiveness. Managers in China seem to be clearly aware of the

relationship between developing new products and processes and their relative

position vis--vis their domestic and international competitors. Indeed, the next four

top objectivesimproving product quality, increasing or maintaining market share,

extending product range and creating new marketscan be seen as specific

manifestations of this more generic competitiveness objective. The next objectives

by importance were responding to R&D projects by competitors, lowering

production costs and obtaining revenues from licensing. Bottom of the list was

reducing environmental damage. (p. 579)

These findings suggest that innovation by Chinese firms is motivated by very conventional

considerations. For a project such as this one, the low ranking given to reducing environmental

damage is depressing. However, the authors further analysis revealed that innovating firms placed a

greater weight on environmental improvement as an objective than non-innovating firms. Likewise,

innovating firms placed a greater weight on improving the conditions and safety of workers than did

non-innovating firms. Perhaps the conclusion to draw here is that while innovation tends to be

motivated by more traditional commercial factors than by sustainability considerations, inducing a

firm to innovate (and therefore leave non-innovating status) itself increases the priority given to the

sustainable motives for innovation.

10 The authors noted that the new-to-the-world product innovations were found in the biotechnology, electronics, machinery, new materials and toys sectors. New-to-the-world process innovations were found in heat-process technologies, specialized conservation techniques for wine, new fermentation processes for pharmaceuticals, and grinding and surface technologies in mechanical engineering (p. 566).


This survey also elicited responses from firms concerning the impediments to innovation (pp. 582

586). Here the findings are revealing precisely because they highlight the relative unimportance of

government-related factors as impediments to innovation. Legislation, norms, regulations,

standards, and taxation were among the lowest-ranked impediments to innovation, along with form

of ownership, resistance to change within the enterprise and the view that prior innovations by the

firm were sufficient. Instead, concerns about the innovation potential of a firm, lack of

information about available technologies, lack of information about product markets, lack of skilled

personnel and the long payoff periods for innovation were seen as the most important impediments.

If these findings are correct, the role implied for the state is one of providing the necessary

ingredients (skilled personnel and information) for firms innovative activities, rather than direct

regulatory intervention.

3.3 Upgrading of specific manufacturing industries

A specific look at the industries can reveal more about the status quo of the upgrading of Chinese

industries. On the global value chain, the upgrading of industries can assume four states:

technological-flow upgrading, aimed at improving productivity through the transformation of

technology and production processes; product upgrading, from the production of simple products at

a lower level to the production of complex and precision products; functional upgrading, from the

low-end links of low added value to the high-end links of high added value on the same value chain;

role-change upgrading, from low-level suppliers of poor technical capability on the industrial value

chain to high-level suppliers having independent know-how and technological property rights.

Meanwhile, according to different driving forces of the industrial chain, the global value chain can

be divided into two types: driven by producers and driven by buyers. For the former, the strategic

links are research and development and the production of core components; for the latter, the

strategic links are design and marketing. Generally, industrial upgrading follows a progressive

process, from flow upgrading to product upgrading, then to functional upgrading and finally to role

change. The process of moving from original equipment manufacturing to original design

manufacturing and then to original brand manufacturing is usually seen as a sequence of functional

upgrading, while the upgrading process from non-strategic links to the strategic links is a symbol of

role change. Different characteristics of industries lead to different status quos and trends in the

upgrading of each industry. We have selected as our cases the buyer-driven textile and apparel

industry and the producer-driven electronic information industry.11 By analyzing and describing the

11 Other recent sector-specific studies of upgrading include studies on mobile phones (Imai & Jingming, 2007) and thermionic values, telecommunications equipment, electrical machinery and office machines (Devadason, 2009). The former study documents the impressive development of the organic mobile-handset industry in China, the growing technical capabilities of domestic firms and the diminished importance of foreign subsidiaries. That study does note that a constraint on innovation by Chinese firms is the availability of specialist engineering talent, confirming a point made earlier in this paper. The latter study compares the exports of Malaysia and China in the four sectors identified above. The author concludes that Chinese firms have quickly established themselves as producers of sophisticated goods and notes the importance of the intensity of competition in the respective markets for these products in China.


two industries, we can roughly judge the achievements and challenges of Chinas traditionally

advantageous industries and rising high-tech industries in upgrading within the new economic

situation.

3.3.1 Textile and apparel industries

The textile and apparel industries are the representative of Chinas traditionally advantageous

industries and also two of the industries that were opened the earliest and widest to the outside

world. At the beginning of reform and opening, the foreign capital introduced by China was mostly

tied to investment projects in the labour-intensive industries of the small and medium-sized

enterprises in Taiwan, Hong Kong and Macau. The textile and apparel industries became two of the

Chinese industries that introduced the largest amount of foreign capital. The textile and apparel

enterprises in Taiwan, Hong Kong and Macau transferred their processing and manufacturing links

to mainland China, especially the Pearl River delta, opening the door for the international textile and

apparel industries to move to mainland China. Since the 1990s global multinationals have flooded

into China, and foreign investment in the textile and apparel industries has grown rapidly. Driven by

these foreign developments and by competition against foreign-funded enterprises, Chinas textile

and apparel industries not only made great progress in processing technology, product quality and

business management but also merged into the global value chain and secured a vast foothold on the

world market.

After Chinas accession to the WTO, large multinationals strengthened the structural upgrading of

their investments in the Chinese textile and apparel industries, which became integrated even more

deeply and completely with the global production system and began to seek upgrading that was

supported by technological progress in the global industrial chain. Table 3.6 shows the increasing

proportion of the foreign-funded economy among the major economic indicators of the Chinese

textile and apparel industries, and Table 3.7 shows the rising proportion of Chinese exports among

global textile and apparel exports. These two data sets are sufficient proof that the Chinese textile

and apparel industries have involved themselves fully in the global production network and have

continuously lifted their position and expanded their influence globally.


Table 3.6 Major economic indicators of foreign-funded firms in the textile and apparel industry, percentage

of respective industry totals. The reported figure for the proportion of total profits in 1995 is in fact the

proportion to total profits and taxes. Source of data: China statistical yearbooks.

Textiles

Year Industrial added

value

Total value of

assets

Product sales

income

Total

profits

Value-added tax payable

in the year

1995 20.28 18.81 17.88 24.89 12.68

2000 20.73 20.76 21.16 24.62 16.32

2003 24.16 24.15 23.34 24.64 16.59

2006 24.85 28.02 24.51 25.70 20.13

Apparel

Year Industrial added

value

Total value of

assets

Product sales

income

Total

profits

Value-added tax payable

in the year

1995 50.02 47.91 50.81 44.79 39.20

2000 48.83 45.35 49.05 50.38 40.88

2003 47.11 44.81 47.28 45.30 39.13

2006 47.39 48.20 45.37 43.12 43.82

Table 3.7 Chinas share of world textile and apparel production. Source of data: www.wto.org.

1990 1995 2000 2003 2006

Global trade of textiles (billion US$) 104.33 151.58 154.74 173.73 218.59

Chinese exports of textiles (billion US$) 7.22 13.92 16.14 26.90 48.63

Chinas share of global trade (%) 6.90 9.20 10.40 15.48 22.25

Global trade of apparel (billion US$) 108.10 158.30 196.78 232.56 311.41

Chinese exports of apparel (billion US$) 9.67 24.05 36.07 52.06 95.39

Chinas share of global trade (%) 8.90 15.20 18.30 22.39 30.63

In recent years the upgrading of the Chinese textile and apparel industries on the global value chain

has been reflected in flow upgrading, product upgrading and functional upgrading.

Through large-scale technological transformation, the textile and apparel industries have witnessed a

great improvement of equipment and production technology. In the period covered by the 10th

Five-Year Plan, imported advanced equipment accounted for 50 per cent of the total investment in

equipment for the textile industry, thereby bringing most domestic equipment up to the

international levels reached in the1990s. Accordingly, the technology for production of textile

equipment has greatly improved. At present, the production of advanced frames for spinning cotton

has been nationalized, so that Chinese-made complete sets of blowing-carding equipment have

accounted for 70 per cent and homemade chemical fibre equipment 50 per cent of the domestic

market for such equipment. New-tech equipment, such as digital printing and screen-making, has

entered the stage of batch production. In some fields, textile and apparel technology has reached or


is close to the advanced international level, for example, in the cases of automatic colour-separation

systems for printing designs and the comprehensive control systems for yarn bleaching and dyeing.

New fibres developed independently in China, such as bamboo pulp fibres, protein fibres and high-

performance fibres, have found use in some important fields such as space flight, military

applications and special uniforms. China has seen breakthroughs in the processing and weaving

technologies for natural hemp, bamboo and true silk fibres (Chinese Academy of Social Sciences

[CASS], 2007, p. 321). In addition, conspicuous results have been achieved in the transformation of

information technology in the textile and apparel industries. Computer-aided design and computer-

aided manufacturing systems are now in widespread use in all links of the textile and apparel

industries, including production, design and product development. Some advanced domestic apparel

enterprises have set up quick response systems for producing small batches and multiple varieties by

leveraging these computer-aided design and computer-aided manufacturing systems (CASS, 2003, p.

158).

Moreover, benefiting from the continuous enhancement of equipment and production technology,

the textile and apparel industries are feeling a palpable itch for product upgrading. Since the 1990s

the product categories of the Chinese apparel-processing trade have gradually changed, from the

predominant underwear, T-shirts and shirts in the early days to apparel products that require more

advanced and complicated technology. These include Western-style clothes, overcoats, and ladies

wear. Many enterprises emphasize the development and application of new fabrics, raw materials

and auxiliary materials and use advanced technologies, resulting in a tremendous enhancement of the

overall level of Chinese apparel products. Chinese enterprises have widely adopted technologies for

non-creasing and no-iron fabrics for shirts, pants and casual dresses. Fabrics that are high-count,

lightweight, and resistant to shrinkage and moths are used in quantity for high-grade suits and

occupational uniforms. Accompanying the trend toward greater environmental protection, the

production of green cloth has also started in China (CASS, 2003, p. 158). Currently, except for some

top-grade apparel, China can produce nearly all complicated, high-end apparel products.

In addition, on the basis of equipment updating and the progress of product technology, the design

capabilities of the textile and apparel industries have expanded quickly, and some enterprises have

begun to shift from original equipment manufacturing to original design manufacturing. The added

value contained in Chinese textile and apparel exports has also been continuously rising. A distinct

new upgrading posture has begun to emerge. The increasingly fierce competition in domestic and

foreign markets, as well as increasing production costs, is forcing the Chinese textile and apparel

industries to hasten the processes of independent innovation and building up their own brands. The

development of new fabrics and new technology through technical innovation has become the

production and operation guideline for textile enterprises, and brand-based growth has become the

common choice of apparel factories, which have long relied on original equipment manufacturing.


In 2007 the growth of profits outpaced that of output, and the growth in export prices outpaced

growth in export quantity for the Chinese textile and apparel industries (Upgrading urge, 2007),

indicating that firms are succeeding in both technical progress and brand management in the

domestic and foreign markets. Meanwhile, government policies have tightened control over energy

savings, reduction of energy consumption and environmental protection. In July 2006 the Chinese

State Environmental Protection Administration released the industry standard Clean Production:

Textile Industry, which guides the environmental protection efforts of the textile industry. The

standard is one of the environmental protection policies promulgated by the central government in

recent years. Ecological environmental protection, energy savings, reduction of emissions and clean

production are the objectives pursued by the textile and apparel industries through their technical

innovations.

But the Chinese textile and apparel industries are also faced with a number of restraints in its

upgrading, which constitute a challenge to the traditional, labour-intensive industries. Rising

production costs are the foremost issues confronting the textile and apparel industry now. As the

largest global exporter of textile and apparel products, China relies on low cost as the strongest

competitive edge for this industry. In recent years, however, the price hikes for domestic factors

such as land, raw materials and labour have caused enterprises production costs to continuously

increase. In 2005 the average annual pay for employees of the textile industry rose by 81.1 per cent

from that in 2000. Data from the State Statistics Bureau show that in 2006, the principal costs of the

textile industry chalked up a year-over-year increase of 21.3 per cent. At present, compared with

some other developing countries, the Chinese textile and apparel industries maintain the upper hand

in industrial matching and market systems, but their edge in production costs basically no longer

exists (CASS, 2007, p. 323). On the global industrial chain, the Chinese textile and apparel industries

have long been among the links of low added value. Given the small scales of enterprises, low

profits and poor capital accumulation, whether or not upgrading can be accomplished before the

cost edge is totally lost has become a critical concern for these industries survival.

Weak innovation capabilities and low levels of research and development are among the major

obstacles for the Chinese textile and apparel industries. For a long time the industries have been held

back by the stress placed on expanding scale of production to the neglect of efficiency enhancement,

and by the stress placed on equipment introduction to the neglect of getting the most out of existing

plants and equipment. The textile and apparel industries fall visibly behind the advanced world level

in the five major technical links of fibres, yarns, weaving, dye-finishing and design. The Chinese

textile industry features low variety, substandard quality and reliance on the import of fabrics for

large-scale garment processing, which seriously hinders the progress of industrial upgrading.

Furthermore, the industry does not pay enough attention to technical innovation, and investment in

research and development is acutely inadequate. The industry not only wants original technology,

with independent intellectual property rights, but also has failed to make a major breakthrough over


the years in the crucial technology that prevents Chinese textile products from rising in grade, such

as deep-processing and after-finish technology. There is even a gap in the research and development

of such new technologies as multi-component fibres, compound fibres and modified fibres. Data

from the general economic survey conducted in 2004 show that the R&D investments by Chinese

textile enterprises accounted for merely 0.287 per cent of sales proceeds, much lower than the

average level of 5 per cent in developed countries (CASS, 2007, p. 321). As cost advantage wanes,

the low technological level and weak R&D power are a stern challenge to the textile and apparel

industries.

Brand popularization and operation is another vulnerability of the Chinese textile and apparel

industries. Of the Chinese garment products sold on the international market, 85 per cent are

original equipment manufacturing products, and less than 10 per cent of them use independent

brands, which are mostly sold to developing countries (CASS, 2006, p. 231). The protracted pursuit

of processing and original equipment manufacturing production has bo

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